Wednesday, December 27, 2006

A Tale of Two Startups

Early this year, Caterina Fake said the startup environment in the Bay Area was giving her the same "sharks in the water" feeling she got in 1998. A lot of really bad ideas blew up during that time, and when the bust arrived, there were some really cool ideas that went down with the bad ones -- Pets.com and all the rest of the stuff that deserved to go. Reid Givens, a web guy in Albuquerque, told me he likes to say the bust flushed the system, got rid of all the crap, but the truth is, it just got rid of everything, the good and the bad. Popular Power was a pretty cool concept.

Recently I had a pretty interesting experience with startups. I talked to a startup looking for Rails programmers. This is startup number one; they're in the Bay Area, so we'll call them San Francisco. I talked to the tech guy there, and after talking to him, I wasn't really that interested. Then I talked to the exec guy, and he got me interested. I did a ton of research about the names he dropped, and I decided they might be onto something. So they scheduled a flight for me to go to the Bay Area and meet with them. So I told this other company I was consulting for, I told them, look, these guys in the Bay, they might want me to start like instantly, they're in this startup hurry hurry mentality, you might need to start looking, and this other company, they were in Los Angeles, they said, well, fly out to meet us as well. Because we might want to fight to keep you. So that was the plan.

(This second company, this isn't the other startup, but it leads to the other startup.)

Anyway, then I talked to the tech guy again, at the first startup, San Francisco, and he said some things about my code which I emphatically disagreed with, and I decided I wasn't interested as much after all, and the flight was cancelled. But I was still scheduled to go to LA, so I talked with the company I was consulting for, and we went through with that trip anyway. And the company I was consulting for, it was basically run by one guy, and this guy had a friend who was having a very interesting experience.

His friend had a small company, startup number two, which we'll call Los Angeles. Los Angeles had built a web app in the Getting Real style, part-time, on the side, only a few people, working cheaply, quickly, and cleanly, without a ton of features, just a few features done exactly right, and he had a ton of interested prospective buyers, and some of them were talking about a lot of money.

So San Francisco, they have connections; they're hooked into the VC world. They have a successful repeat entrepreneur coming on as co-founder and they have kickass backers. (Yes, coming on as co-founder. Little cognitive dissonance for you?) And they told me, they kind of feel that any company that makes less than $100 million is kind of a failure.

So Los Angeles is selling for less than $100 million, but several multiples of what they spent to build the thing. This startup built on the side and being sold for a lot of money, that's a new thing. That's like a 37 Signals thing, a smart thing that survives the hard times and makes hella money in the good times. San Francisco, whose goal is to make tons and tons of money and then sell the company to somebody, all without any expectation of actually charging anybody for anything, this seems like something I've seen before, and the last time I saw this, it didn't go so well. In fact it went pretty badly, and in retrospect, everybody involved looked pretty stupid.

So you've got San Francisco, on a mission to make $100 million, and you've got Los Angeles, actually making money, but less than $100 million. Of course the question is how much less, and I can't say, but it's not so much less that anybody's crying for the Los Angeles guys and their terrible loss. Oh no, quite the opposite. The guy from Los Angeles I was talking to, I think he was incredibly cool not to be wearing a shit-eating grin all day long.

I think what's going on here is that the venture capital system is based around the idea that companies require substantial investment to get going. But that isn't true any more. (Huge hour-long mp3 behind the link, absolutely worth it.) Infrastructure means open source software and bandwidth. Bandwidth is cheap, and open source is free.

Every venture capitalist wants that huge success, the big disruptive innovation that destroys old industries and makes them millions.

The irony is, the biggest disruptive innovation that ever came from the Internet could in fact be open source software, and the old industry it destroys will probably be venture capital.

Think about it. Free software and cheap infrastructure basically eliminates the whole raison d'etre for venture capitalists. Companies are cheap to start. All the stuff you used to need millions for is now free. That means venture capitalists just don't matter any more. It isn't about being lucky enough to get $5 million in funding; it's about starting something with the cash in your pocket. If you make something and it's good enough, the guys with $5 million in funding will come to you, because those guys are basically just money in search of intelligence, and it's a lot better to be intelligence in search of money. If you're intelligence in search of money, you'll choose the best way to get money. The best way to get money isn't to find some VCs to beg, borrow, or steal from; the best way to get money is to make something people will pay for. So if you're intelligence in search of money, you'll make stuff people want to pay for, and you won't even bother with the VCs, because they need you more than you need them.

Raganwald has a pretty kickass post about this very subject, and his conclusion is that nine out of ten times, you don't want to work for a startup. 37 Signals has a great fucking book about how VC funding for startups is stupid and the Los Angeles model is smart.

And me? Today, I'm going to send out resumes to a bunch of startups.

Good question.

Let me explain.

There's an important piece of the picture which both Raganwald and 37 Signals are missing.

You can glimpse it here. It's a case study of the Flickr acquisition, and it concludes:

So what was Yahoo’s motivation to acquire Flickr? Flickr was acquired into the Yahoo search group, thus indicating Yahoo’s intention to integrate Flickr photos into the general image search engine. It’s interesting that the acquisition was not initiated by the Yahoo Photos group, thus revenue, revenue growth, and profit were not the main motivations for the acquisition. Secondly, Flickr had developed a robust tagging platform that could be applied to other Yahoo products. Third, Yahoo was interested in acquiring the people behind Flickr and absorbing their thinking and DNA into the company. The least important factor in the acquisition was the user community that Yahoo acquired. While Flickr’s growth and buzz were important in validating the technologies that Flickr pioneered, the sheer number of Flickr users was not an important factor in the acquisition. Thus, at its heart, the Flickr acquisition should be thought of as a technology and people acquisition.

If you're really productive, why not make employers pay market rate for you? Why go work as an ordinary employee for a big company, when you could start a startup and make them buy it to get you?

When most people hear the word "startup," they think of the famous ones that have gone public. But most startups that succeed do it by getting bought. And usually the acquirer doesn't just want the technology, but the people who created it as well.

Often big companies buy startups before they're profitable. Obviously in such cases they're not after revenues. What they want is the development team and the software they've built so far. When a startup gets bought for 2 or 3 million six months in, it's really more of a hiring bonus than an acquisition.

What a lot of people don't realize about startups is that Silicon Valley creates such a huge number of startups not just because of the casino factor -- the "maybe this time we'll get lucky factor" -- but also because it's a fantastic recruiting system. Compare it to sorting resumes, for instance. No resume I've ever seen in my life records the number of hours worked in an average week, or contrasts average weeks with unusual weeks, let alone providing the standard deviation, but if you see startups on the resume, you know you're dealing with somebody who will work hard. The smaller the company when they joined it, and the larger the company got, the more likely they have some capacity for leadership -- and that's true irrespective of their title at the company, and irrespective of what their resume says they did there. The more unusual the problem their startup addressed, the more likely they have the capacity to solve challenging problems in original ways. These are all good things, and that's just if the startup fails, because you wouldn't be looking at a resume if it succeeded.

If it really works out, and the company gets bought, huge companies with gigantic money-making machines that need smart people behind the wheel suddenly have very smart people behind that wheel.

So I've been mostly working for startups for the past six months. This is a new strategy in my career, but I have faith in it. Part of the reason I work for startups is, it makes me look good. It also keeps my brain healthy by putting interesting challenges in front of it. But a more important reason is the people.

If you're working with somebody at a startup, you know that they think it's possible they might be one of the best in their field, and they're willing to work very hard to prove it (or to find out otherwise). You also know that they're working sufficiently hard that they will absolutely demand your best, and boot you if you provide anything less. A lot of people might consider that high-pressure, and it is, but high pressure is often a result of high standards, and high standards are a very good thing.

Obviously what I'm talking about doesn't have much to do with the type of entreprenuers Caterina mentions in her post, the ones she sees in pictures from literally every Valley party. It doesn't have a lot to do with every single startup I've worked for or had friends at. There's no doubt the world of startups contains more than its fair share of bullshit. Every startup I've talked to, I've asked a lot of questions of, and some of them, the answers were so stupid I felt sorry for them. Confidence does not always come from experience or insight. But that's why you ask the right questions. It's called due diligence.

But the final reason I'm going to send resumes to startups?

Have you ever seen a tiger, in person?

If you haven't, you should hurry up, because they are much closer to being extinct than anybody who is reasonably safe from being eaten by one would ever wish. They are much, much closer to being extinct than many people even realize. These are beautiful, magnificent creatures, and one day, they may be gone.

7 comments:

Your reason for joining startups seems to dovetail nicely with what you want out of life. Go for it!

Although my post was far, far too long (I could have summed it up by saying that working for a startup is unlikely to make anyone a lot of money), I tried to stay on one topic: the financial implications.

I've started companies and worked for startups, so I do appreciate the non-monetary rewards available.

I wish you well and greatly regret that I am neither hiring nor seeking co-founders at the moment. My loss will be another founder's gain.

I liked your post. I think another good reason to work at startups is because it's fun, but you seem to cover that.

I'm glad you liked the Popular Power idea (I was one of the co-founders). I agree it was a cool idea, but the market was weaker than I'd hoped, regardless of the bubble burst. More recently I co-founded another startup, Wesabe, which I think is also a cool idea but in a much better market. And as it turns out we're hiring Rails programmers. Drop me a line at marc at wesabe if you want.

Interesting article! The open source stack is one reason startups can get real without being capitalized - Amazon S3 may become another. Not needing to prepay for the storage you hope to grow into is a huge advantage.

"So if you're intelligence in search of money, you'll make stuff people want to pay for, and you won't even bother with the VCs"

Oh yes, I wholeheartedly agree! This has always been true, eBay was built on the same principle. The only time it needed venture capital investment was when other investors wouldn't take it seriously without venture capital! So they took $5m and put it in the bank. It's probably still there...

It's a different scene outside of SV. Oh look, it's another tired job description written by a lifeless HR drone. Yawn.

I've dropped Big Companies and Big Technologies in favor of project-oriented work and open source tools.

Of course if you can't find a startup, you can start one. And having less VC money available may actually be an advantage if it forces a startup to develop a useful product with a viable business model.